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The long-standing efforts of the government over the last decade to rationalise the Treaty with Mauritius bore fruit earlier last month with the protocol being signed on May 10, 2016. The island nation of just 1.3 million people has been the biggest single source of foreign direct investment (FDI) into India. In 2015, Mauritius was recorded to be the top contributor of FDI in India, accounting for 29 percent of the total FDI, pushing Singapore to second place. While the phase out of capital gains tax exemption on shares has been at the centre of attention, a closer look at the protocol brings about other revelations that can have far reaching implications. This article seeks to bring to light such revelations.
Is the capital gains exemption party really over? The black and white of the protocol entails the phase out of the capital gains tax exemption to be limited to ‘shares’ and instruments like debentures and derivatives are not in its realm. The economic affairs secretary also clarified this in a press statement where he mentioned that gains from derivatives and other forms of securities like compulsorily convertible debentures and optionally convertible debentures will continue to be governed by the existing provisions. This coupled with the low tax rate of 7.5 percent on interest introduced in the protocol should make Mauritius the jurisdiction of choice for debt /derivate instruments in the coming times.
Another interesting observation is that the language of the protocol which subjects transfer of shares acquired post April 1, 2017, to tax, does not cover ‘indirect transfers’ within its ambit, which means that transfer of shares in a Mauritius holding company holding an Indian company should continue to be entitled to claim capital gains tax exemption under the treaty.
It will be worth taking note of the fact that that the Limitation of Benefits (LOB) provisions introduced under the protocol are applicable only to avail the 50 percent capital gains tax rate during the transition period. Hence, no LOB provisions are applicable to claim the capital gains tax exemption benefits in respect of debentures /derivatives or in respect of indirect transfers, while the General Anti-Avoidance Rules (GAAR) should apply as per the domestic regulations in India.
Is Mauritius the new jurisdiction of choice for interest income?
The protocol has introduced a tax rate of 7.5 percent on interest income that will apply to debt instruments subscribed by a Mauritius resident in an India entity. Prior to this amendment, the Mauritius Treaty provided for interest to be taxed as per domestic regulations which entailed a potential tax rate of 40 percent-plus surcharge and cess for interest on rupee denominated debt instruments subscribed by Mauritius residents in India.
The 7.5 percent tax rate on interest is the lowest that India has in all of its Double Taxation Avoidance Treaties entered into so far. The lowest tax rate on interest prior to this was 10 percent that was prevalent in many treaties entered into by India while the treaties that were more sought after than the others were Cyprus (until it was blacklisted), The Netherlands and Luxembourg primarily on account of their domestic tax rates. Given the low domestic tax rate in Mauritius and with the capital gains exemption on transfer of debt instruments being available, the 7.5 percent tax rate for interest is likely to make Mauritius a sought after jurisdiction for debt instruments.
Nuances in the Service PE clause
The protocol has introduced the concept of a service PE as per which services rendered by a Mauritian resident for a period more than 90 days in any 12-month period will constitute a PE in India.
Contrast with other Indian treaties that limit the scope of a service PE clause to onshore services, the language in this article covers services rendered offshore as well. While it may be a difficult preposition to allege a PE for offshore services, this could lead to a string of litigation that would have to be dealt with by the courts.
Also, while Service PE clauses in the other Indian treaties normally contain an exclusion for fees for technical / included services that are dealt with under a separate Article, the Article in the Mauritius protocol does not contain such an exclusion which means that fees for technical services could potentially be covered under the service PE clause under the Mauritius Protocol.
Fees for Technical Services (FTS) article introduced
The protocol introduced an article on Fees for Technical Service (FTS) in line with similar articles existing in various other treaties entered into by India providing for taxation of the FTS income sourced in India at 10 percent in India
Taxation of other Income made source based
The Protocol has amended the ‘Other income’ article that previously provided only the country of residence the right of taxation, to now allow a taxing rights to both, the country of residence and the source country, thereby allowing India to exercise taxing rights to tax residual income sourced in India. This would impact the arrangements such as gift of shares, liquidation of a Mauritius Company having accumulated profits that would have been sheltered under the earlier resident based tax regime.
The other amendments brought about by the Protocol are introduction of an article each on Exchange of Information and Assistance in Collection of Taxes and these are largely in line with information exchange agreements and assistance in tax collection being sought by India with various other countries.
All in all, the Government has achieved a momentous result with the Protocol bringing down curtains on the capital gains exemption that has prevailed and benefited many for over 33 years. While Mauritius is likely to step down from its position of top FDI contributor to India post this protocol, it should still remain in the limelight for the new avenues on debt and derivative instruments.
-By Manoj N Kumar, Partner, BMR & Associates LLP